Basics of Estate Planning: Medicaid Planning and Trusts

This is another in a series of blogs on the basics of estate planning. In the last blog in the series, we looked at the different types of revocable trusts for different family situations. This week, we’ll look at how trusts may be used to help with Medicaid planning.

Today’s estate planning is about more than just planning for death. Today, estate planning is about helping people prepare for difficulties during life, helping them pass their assets in the best way at death, and helping them preserve their legacy after they’re gone. Part of this planning process may be to help them plan their affairs so that they qualify for the Medicaid program if they need assistance with a nursing home, assisted living facility, or in-home care, collectively referred to as long-term care (“LTC”).

Medicaid is a joint state / federal program in which the broad outline of the rules is set by federal law and each state has their own interpretation on implementation. As a result, the rules vary somewhat by state. But, generally, there is a limit to the amount of assets a person can have and still qualify for Medicaid. (There also may be an income test in some states.) Certain assets are not countable resources, such as a personal residence. But, someone cannot simply wait until they need Medicaid and then give away their excess assets. There is a 5-year lookback on uncompensated transfers. So, when it comes to Medicaid planning, it pays to think ahead.

There are two types of trusts which are often used in Medicaid planning. The first type of trust is a “Family Income Trust,” also known as a “Medicaid Income Only Trust,” or a “Medicaid Income Defective Grantor Trust,” or “MIDGT.” This is a trust which the grantor sets up and retains the right to all income. The grantor is prohibited from receiving any other distributions and is not the trustee (though this may be permitted in some states). At the death of the grantor, the property goes to the pre-determined beneficiaries in the manner set forth in the trust. Thus, it is possible to keep the assets in further trust to protect them from the creditors or immaturity of the beneficiaries. The grantor may keep a limited power of appointment, both during life and at death. These powers of appointment increase flexibility and cause estate tax inclusion and, therefore, a step-up in income tax basis at death. The rights retained by the grantor also make this trust a grantor trust for income tax purposes. In other words, the trust uses the grantor’s social security number and all items of income and expense go on the grantor’s income tax return as if the trust’s assets were held by the grantor directly.

The second type of trust is a “Family Discretionary Trust,” or “Medicaid Discretionary Trust,” one in which the grantor has no rights to any distributions whatsoever. The trustee has discretion to make distributions to beneficiaries during life. At death, the assets go to the beneficiaries as set forth in the document. As with the income only trust, the grantor should not be the trustee and there may be powers of appointment to cause inclusion in the taxable estate and, therefore, a step-up in basis. There may be powers triggering grantor trust status, as well.

Since the grantor has no rights to the principal of either of these types of trusts, the assets of the trusts are not countable resources when the grantor applies for Medicaid. If these trusts are created and funded at least five years before the grantor’s application for Medicaid benefits, the transfers into the trusts need not be reported and there is no penalty period applicable to the transfers. The income from the income trust, which is paid to the grantor, is countable, of course. While this remaining income stream may give clients security prior to the need for LTC and Medicaid benefits, the income might be lost or, in some states complicate qualification because of income limits.

It is critically important that the trustee and the grantor respect the trust as a separate entity and abide by the specific terms of the trust. As long as they do so, these trusts can be a great way for the client to protect assets for their children or other beneficiaries and qualify for Medicaid, with sufficient advance planning.

In upcoming blogs in the series, I’ll cover more on the Basics of Estate Planning.

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